'New normal': low rates, high dollar

Cuts in interest rates are proving less effective in lowering the dollar and boosting business activity than might have been expected, but are still working to support the economy overall, Reserve Bank deputy governor Philip Lowe says.

Mr Lowe also argued that lending rates across the economy should be lower than in the past couple of decades, in part to offset the impact of an "uncomfortably high exchange rate".

A 3 per cent cash rate today is not the same as a 3 per cent cash rate in the past.

The RBA this week cut its cash rate a quarter point to a record-matching low of 3.0 per cent, seeking to stimulate sectors outside mining which have been struggling with the strong dollar and a more prudent consumer.

But Mr Lowe identified two areas where the easing to date was having less effect than in the past.

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"In particular, while a number of household indicators have picked up somewhat, business confidence and conditions have not. This difference will obviously bear close watching over the period ahead," Mr Lowe said in a speech to business economists.

"One other area where the response has been smaller than typical is the exchange rate, which has remained high."

The Australian dollar actually rose to near $US1.0500 this week even after the RBA cut cash rates to levels last seen during the global financial crisis, when the currency was closer to 60 US cents. In late trade on Wednesday, the dollar was trading at $US1.048.

"The more important conclusion, though, is that monetary policy still looks like it is working," added Mr Lowe. "There are lags and different parts of the economy respond differently, but lower interest rates are still effective in providing a boost to the overall economy."

What is normal?

In a speech entitled "What is Normal?", Mr Lowe reiterated that official rates needed to be lower than in the past because bank funding costs, and so mortgage rates, had risen relative to the cash rate.

"The fact that the bank has offset the effect of higher funding costs on lending rates means that the normal level of the cash rate is lower than it otherwise would have been," he said. "A 3 per cent cash rate today is not the same as a 3 per cent cash rate in the past."

This is one reason some analysts argue the RBA will have to cut the cash rate further to pull lending rates in the economy down to levels that truly stimulate demand.

Indeed, Mr Lowe himself said there were reasons to believe the new "normal" for lending rates might also be lower, at least for a time.

One reason was that the major advanced economies were pursuing aggressive easing policies that had weakened their currencies, but in turn lifted the exchange rates of better-off countries such as Australia.

"This is one of the mechanisms through which the weak conditions in most of the advanced economies are transmitted to the rest of the world," said Mr Lowe. "And in response to this, interest rates are lower than they otherwise would be to offset some of the effects of an uncomfortably high exchange rate."

Mr Lowe said weaker demand for credit coupled with the recent fall in Australia's terms of trade, could also be expected to lower average lending rates compared to the past.

"It is possible that normal lending rates will be somewhat lower for a period owing to the combination of global factors and the legacy of the credit boom," he said.